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External Stability

External Stability. CAD, BOP, TOT, NFD and the Australian Dollar. Definition. External stability looks at how we transact with other countries overseas. When we purchase products made overseas this is known as imports (M) When they purchase products from us this is known as exports (x).

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External Stability

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  1. External Stability CAD, BOP, TOT, NFD and the Australian Dollar

  2. Definition • External stability looks at how we transact with other countries overseas. • When we purchase products made overseas this is known as imports (M) • When they purchase products from us this is known as exports (x)

  3. Measurement of External Stability There are three measures or indicators of external stability: • The size of Australia’s Current Account Deficit (CAD) • The exchange rate for the Australian Dollar • The net foreign debt (NFD).

  4. CAD (X – M) • The Government aims to keep the Current Account Deficit (CAD) at low levels of around 3% of GDP • The CAD is a component of the BALANCE OF PAYMENTS (BOP)

  5. The Balance of Payments • The Balance of Payments account is an annual statistical record of the money value of different types of transactions between Australia and the rest of the world Credits are money that comes into Australia (for the sale of our exports) Debits are money that flows out of the rest of the world (for the purchase of imports)

  6. The overall balance of payments account is divided into the: • Current Account and the • Capital and Financial Account The BOP always balances and it is the Current Account that we are most interested in. Copy the diagram on pg 228 of your text book Economics Down Under Units 1 & 2

  7. CAD The Current Account is broken into four sub accounts: • Net Goods • Net Services • Net Incomes • Net Current Transfers

  8. Debits and Credits • Payments to foreigners on the current account are recorded as debits • Payments received from foreigners to us are recorded as credits on the current account. • When debits exceed credits then it will be recorded as a deficit.

  9. Difference between the Current Account and the Capital Account • The current account records things that do not result in any future obligations whereas the capital transactions do result in future obligations. • Eg loans and interest paid on those loans result in future obligations and therefore are recorded on the capital account.

  10. Look at the table Components affecting Australias current account deficit (CAD on pge 231) • Have a go at calculating how they got the figures in table 8.3. Use table 8.2 to calculate the annual CAD figures for the year ended 30 June 2010. Provide a possible explanation for the movement in the CAD over the financial years 2009 and 2010. (see my spreadsheet calcs for help) • Answer Multiple Choice Qs 8 from 2011 exam paper

  11. The Capital and Financial Account (CAFA) • The financial Account in the CAFA is the most useful thing for us to look at. Effectively it shows how we finance our CAD. • If we import more than we export then we need to pay for those imports. Typically Australia finances the CAD in the form of loans (debt) or the sale of Australian assets which leads to an increase in Australia’s net foreign liabilities or NFD.

  12. Answer questions on pg 157: • 1, 4,5,6,7,8,9

  13. The effects of Australia’s CAD and reliance on OS borrowing • Australia has a large CAD, mainly because of our heavy reliance on overseas borrowing and foreign debt. • The interest on this debt is recorded in the Current Account in the Net Primary incomes section.

  14. Weakens the exchange rate • When the CAD is large, this means we are importing more than we are exporting. • To pay for the imports we need to supply Australian Dollars Overseas. • When we supply more AUD overseas this places downward pressure on the value of our dollar.

  15. Increase the foreign Debt • A high CAD means we are importing more than we are exporting. • To pay for this difference we need to borrow money from overseas. This results in increased Net Foreign Debt. • Net Foreign Debt must be paid back with interest, which further increases the CAD.

  16. Policies may be needed to slow spending and AD • If the CAD is too high, the government may want to slow spending on imports, but it is generally only possible to slow overall spending, not target imports directly. • Contractionary measures such as higher interest rates or increased tax rises may be used which has a slowdown on all economic activity.

  17. Higher Interest Rates • If the size of the CAD is too high and leads to an increase in our net debt this may adversely affect Australia’s credit ranking. This could result in higher interest rates charged on the money we borrow from overseas.

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